Climate Resilience: Parametric Insurance and Blockchain (Part I) 

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Building resilience to natural disasters is key to climate change adaptation, which is a central element of the Paris Agreement.

Whilst insurance may not be the first thing that comes to mind when thinking about climate change, it is an important tool to help protect individuals and businesses from the rise of climate-related disasters. Yet, currently, traditional insurance only covers a small fraction of the economic loss caused by such incidents. In 2021, the globe lost roughly $343 billion as a result of natural disasters but over 60% of this was not insured.1  

It is, therefore, undeniable that a new approach to insurance is necessary to provide coverage for a dynamic risk environment. Parametric insurance is one such approach.

What is Parametric Insurance?

Most consumers are familiar with traditional insurance, also known as indemnity insurance, which reimburses the insured for the actual loss or damage incurred after a specific incident.2 For example, an insurer would cover the costs of fixing a vehicle after a car accident. Conversely, parametric insurance is not based on compensation of actual loss but rather, an ‘if-then’ model; if a pre-defined event occurs, then pay-out is made. A parametric insurance policy contains two key features: a triggering event and a pay-out mechanism.3  

A triggering event refers to an event taking place that meets or exceeds a certain pre-defined metric, such as an earthquake exceeding a minimum magnitude within a defined area or wind reaching a certain speed. Whereas in traditional insurance, payment is made only after an evaluation of an actual loss or damage, payment in parametric insurance is automatically made upon the occurrence of the triggering event.

A pay-out mechanism defines the pre-agreed amount paid out to the insured should an event meet or exceed the defined threshold. For example, an agreed payment structure could reflect a positive correlation between pay-out amounts and earthquake magnitude. Since payments are based on a triggering event rather than actual damage, the amount paid in parametric insurance may be higher or lower than actual loss.

Parametric insurance for climate resilience

Two main characteristics of parametric insurance render it an ideal tool to support climate resilience.

Firstly, parametric insurance enables quicker payments as it negates the need for lengthy investigations and damage evaluations. For instance, after the 2010 Haiti earthquake, the Caribbean Catastrophe Risk Insurance Facility (CCRIF), an insurance organisation, made their pay-out merely fourteen days after the event through parametric policies.4 As natural disasters often require emergency responses, fast pay-outs can prevent situations from getting worse and kickstart disaster relief actions. 

Secondly, the pay-out from a parametric policy is flexible as there are few restrictions as to how the pay-outs can be used. Therefore, in the event of natural disasters, the insured can freely apply the funds to where they are needed the most, thereby accelerating the recovery process.

Applying IoT and blockchain technology to parametric insurance

As parametric insurance is heavily data-driven, both the insurer and the insured must have confidence in the quality of data that forms the bedrock of this type of insurance. Any parameter being used must be objective, transparent and consistent – usually provided by independent, third-party sources, such as typhoon warning signals by the Hong Kong Observatory and earthquake magnitudes by the US Geological Survey.

Rather than depending on a middleman, however, the combination of Internet-of-Things (IoT) and blockchain technology can actually enhance the operation of parametric insurance policies. IoT can collect and provide real-time data that can then be stored on blockchains, which are immutable, decentralised and transparent. Not only does this help provide accurate data, but it also removes the risk of data manipulation and boosts consumer trust.

Furthermore, blockchain technology can be used for smart contracts, which are programmes stored on a blockchain that can run automatically when predetermined conditions are met. Insurers can, therefore, code the underwritten terms of agreements into smart contracts. These self-executing contracts eliminate the need for manual involvement, which can be time-consuming and prone to human errors, thereby streamlining the process of executing a parametric insurance policy.

BCI has led various projects that explored the marriage of technology and parametric insurance. Amongst these was a fully decentralised coverage programme that allowed Cambodian farmers to hedge against weather risks by using blockchain-based parametric coverage products facilitated by smart contracts. Another project BCI led was an investigation into the demand, technical feasibility and economic viability of blockchain-based climate catastrophe insurance (BBCCI) in Fiji.5 The study identified the advantages of BBCCI, including increased standardisation, lower fraud risk and increased transparency, and illustrated the recommended roadmap for the Fiji government to implement BBCCI in the country. 

Claudia Wai Lam Chan (RO(III)4) 

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